During the past week, the IMF mission held discussions with the Bulgarian authorities. In the context of the first review of the Stand-By Arrangement (SBA) approved by the IMF's Executive Board on August 6, 2004, the mission's discussions focused on program implementation to date and economic policies for 2005, especially fiscal policy. We thank the Bulgarian authorities for their cooperation and hospitality.

The macroeconomic situation continues to be broadly favorable, but strong demand pressures and external vulnerabilities remain. We expect real GDP growth to have been 5¾ percent in 2004 and to be 5½ percent in 2005. Annual inflation has fallen rapidly, and is expected to drop to a little more than 3 percent by the end of 2005. The external current account deficit was slightly below 7½ percent of GDP in 2004, more than 1 percentage point better than projected at the time the program was approved. However, even with appropriate fiscal and incomes policies, we expect a marginal worsening in the external current account deficit in 2005, as the higher average oil prices offset improvements in other components. Growth of bank credit is likely to remain very strong in the first quarter of 2005, at nearly 50 percent on an annual basis, but to decline sharply thereafter as the measures to restrict credit growth recently announced by the BNB take effect. The gross external debt ratio increased in 2004 but is expected to return to its declining trend in 2005.

Implementation of the program so far has been broadly satisfactory, although there have been some slippages, both in the macroeconomic and structural reform areas. There were breaches of some quantitative and structural performance criteria under the program for end-December 2004, but these were mostly minor and will largely be addressed before completion of the first review. The government ran a very responsible fiscal policy in 2004, ending the year with a surplus of 1¾ percent of GDP, thus helping to improve the external current account deficit. In 2004 the BNB took several steps to reduce liquidity in the banking system, and has now announced more direct restrictions on credit growth.

The mission agreed, ad referendum, with the authorities on economic policies for the remainder of 2005. In the current environment, continued prudent macroeconomic, incomes and structural policies are necessary to strengthen the foundations for sustained high rates of growth and to ensure the viability of the currency board arrangement. We have agreed that the improved current account position allows a relaxation of fiscal policy compared to 2004, to a surplus of 1 percent of GDP in 2005. This involves an increase in government spending in real terms of approximately 6 percent in 2005. Structural conditionality under the program continues to focus on improvements to the business climate, as well as on establishing the legislative basis for the successful implementation of the National Revenue Agency from January 1, 2006. We expect the Executive Board of the IMF to complete the first review of the stand-by arrangement on May 18, 2005.